'By virtue of exchange, one man's prosperity is beneficial to all others.' – Frédéric Bastiat

Musings on Bitcoin

With the financial instability in Europe and the inflationary policies pursued by central banks everywhere from America to Japan to New Zealand, the demand for Bitcoin has rocketed to an all time high of 72 USD per BTC (compared to October 2012 which saw BTC at a rate of only 12 USD). Bitcoin is a decentralized digital currency based on an open source, peer-to-peer network. There is no central bank, there is simply an automatic, decentralized and scheduled algorithm that controls the money supply. This makes Bitcoin appealing to so many libertarians and technology enthusiasts. By design, the currency is beyond political manipulation. It is international, anonymous, and tax evasive. Financial pundit Max Keiser called Bitcoin “the currency of resistance.” There are now $700 million worth of Bitcoins with new outlets offering products for Bitcoins every month. Bitcoins are expanding beyond the stereotype of being only used for the sale of drugs. An Albertan man has now listed his house for sale for $405,000 worth of Bitcoins!

Bitcoin is a market anomaly I struggle to explain. While the concept is truly romantic, I stand by my objections towards the product despite the successes being witnessed today. I hold the traditional view that money is simply the most liquid good in an economy. In a free market society money arises for a good because it is easily transferrable, it is scarce, and most importantly, because there exists an initial demand for the good itself. This is why precious metals have historically arisen as money. While many people may not care much for gold itself, it has transaction value in trade because somewhere down the road there exists an individual who wants that gold. The same can be said with the spontaneous use of cigarettes in prisons. Even individuals who have not smoked in their life strive to acquire cigarettes because of the goods they can purchase. In this case, the demand for cigarettes equates to the demand for the things that those cigarettes can buy. To the non-smoker, cigarettes in themselves are entirely valueless but that is not important, what is important is that cigarettes in themselves are eventually valued by somebody and that is what forms the basis of their transaction value.

Bitcoin is not an example of this (as is our Canadian bills). While cigarettes are consumable, one cannot consume Bitcoin. Conversely, one can consume gold by turning it into consumer products such as superconductors or jewelry. Nobody really understands why Bitcoin is valued the way it is. I theorize that the value of Bitcoin is partly fueled by ideological motivations (rather than economic motivations) and premature enthusiasm for a novel idea before truly understanding the fundamentals. I also believe that Bitcoin is a speculative bubble where people wish to acquire Bitcoin because other people wish to value Bitcoin and so on and so forth. This however is unsustainable as without an initial demand this regression loop will eventually fall apart. For the most part, the demand for Bitcoin is not at all equal to the demand of things Bitcoin can buy. 97% of all holders have an amount less than 10 BTCs. Throughout the history of Bitcoin, 88% of all users have never owned more than 10 BTCs. Being a libertarian, I have probably a dozen friends who own Bitcoin. None of them however have ever bought anything but are waiting for a further appreciation and new opportunities. This makes Bitcoin a speculative commodity rather than a currency. People don’t want Bitcoin to consume Bitcoin. People don’t even want Bitcoin to exchange it. People want Bitcoin under the assumption that demand for Bitcoin will continue to rise. Unfortunately, this is unsustainable. The situation is vaguely reminiscent of the unsustainable housing boom where there was no actual demand for the houses being built but new homeowners were coming to the market under the assumption that prices would continue to rise.

When the true value for Bitcoin is eventually properly expressed by the markets, there is no telling how far the price will fall in absence of an initial demand. I believe that many first time investors will be too disappointed and traumatized that they will not go back. The difference between Bitcoin and our government fiat is that our dollars are in fact backed by something- coercion. Our dollars are sustainable because the government is able to impose their monopoly on money through legal tender laws. If this were not the case, our money would be worth no more than the paper they are printed on. I hate to be a party pooper but I just do not see the Bitcoin revolution happening.